Deal or No Dealership

Why is Chrysler closing 789 car dealerships?

Chrysler disclosed in a bankruptcy filing last week that it plans to close 789 dealerships—about one-quarter of its total. General Motors, meanwhile, told the owners of 1,100 dealerships that it will drop them from its network. How does shuttering dealerships help car companies?

It saves them money. Car companies don’t actually own dealerships—instead, they have contractual agreements that dictate factors like location, display space, signage, and service options. Nevertheless, Chrysler and GM and other auto manufacturers must maintain a large, costly field force of trainers (to train technicians to fix cars), salespeople (to persuade dealers to buy more cars), and auditors (to verify claims for reimbursement). The more dealerships, the more go-betweens a car company needs to employ and the more money it has to shell out.

Shuttering dealerships could also result in less intra-brand price competition. Car buyers will typically visit at least two different dealerships in order to compare prices before making a purchase. By playing dealers against one another, buyers lop an estimated 2 percent off revenues. But if there are fewer dealers, customers can’t haggle as easily, and car companies make more money. There’s a tradeoff, of course—fewer dealerships means customers have to drive farther. But at the moment, there are so many dealerships that the benefits of reducing price competition outweigh the harm of having fewer locations.

Another benefit: Shutting down dealerships weeds out weaker branches to help stronger dealerships stay viable. It also makes sense from a branding perspective, because when a dealership starts to fail, dealers resort to tactics that make the car company look bad. Think free hot dogs, “push, pull, or drag” sales, and giant inflatable gorillas on the roof. (Luxury car companies like Lexus explicitly forbid dealers from using the words price or sale in their ads.)

Finally, pre-emptive closings help car companies from getting saddled with tremendous amounts of debt. Let’s say a GM dealer is just getting started: He’ll buy hundreds of cars from GM with money borrowed from GMAC, the financing arm of GM. If the dealership collapses suddenly, GMAC may not get a lot of the money it’s owed. So it makes sense for GM to shutter a dealership before it goes too far into the red.

When the auto industry first started expanding in the early 20th century, it made sense to have dealerships in every community. Much of the population was rural, and cars broke all the time, making proximity to the original vendor necessary. These days, with a more urban population and better auto engineering, it’s not necessary to have so many dealerships. At the same time, people are willing to drive farther to buy or tune up their cars. As a result, more dealerships don’t correlate with more sales. Toyota sells more cars than Chrysler with fewer than one-third of the number of franchises. (The average Toyota dealer sold 1,589 vehicles in 2008; the average Chrysler dealer sold 124.)